IPE Everywhere: The Original Tea Party

It was less about principle than we often believe:

Indeed, for consumers, anger over the tea tax had never made much economic sense. For one thing, many drank Dutch-supplied tea, which was smuggled and therefore tax-free. Benjamin Woods Labaree, the most attentive scholar of the Colonial tea trade, estimates that three-quarters of the 1.2 million pounds of tea that Americans consumed each year was smuggled. Meanwhile, the tax on legal tea was largely offset by a tea-tax refund passed the same year. But in 1772 that tax refund shrank, making British tea more expensive and enhancing smugglers’ price advantage. Tea piled up in the British warehouses of the East India Company, which owed money to the British government and also needed to ask it for a loan. Someone had an idea: why not raise cash by dumping the company’s surplus tea on the American market? Parliament agreed to help by restoring the old refund in full and by allowing the company to export tea directly rather than through merchant middlemen. With the new measures, the price of legal tea was expected to halve. Consumers would save, Parliament needn’t lose quite so much on its bailout of the East India Company, and smugglers would be driven out of business.

Boston’s big businessmen felt threatened. Not only might smuggling cease to be profitable but, if the experiment of direct importation were to succeed, it might cut them out of the supply chains for other commodities as well.

The whole article is about how prominent businessmen -- who were often smugglers as well -- riled up the public to support their (the businessmen's) economic interests. Highly recommended.

Via Blattman

The Etymology of 'Tariff' and 'Austerity'

Thus, it seems the term "tariff" was first applied to designate the "rates," or duties which the Roman Catholic priests levied upon sins.

Via Simon Lester, more here. It comes from the Arabic d'araf, meaning "to know".

As for 'austerity', this article gives the run-down on Merriam-Webster's 2010 Word of the Year, and includes some quotes from IPE prof (at Brown) Mark Blyth (who is researching a book on the topic). We covered Blyth, and a video preview of his book, previously.

Not All Trade Protections Are Created Equal

The abstract of a new NBER paper (ungated pdf here):

Over the past decades, the steel industry has been protected by a wide variety of trade policies, both tariff- and quota-based. We exploit this extensive heterogeneity in trade protection to examine the well-established theoretical literature predicting nonequivalent effects of tariffs and quotas on domestic firms’ market power. Robust to a variety of empirical specifications with U.S. Census data on the population of U.S. steel plants from 1967-2002, we find evidence for significant market power effects for binding quota-based protection, but not for tariff-based protection. There is only weak evidence that antidumping protection increases market power.

An interesting follow-up would be to see if this dynamic affects political organization, or if industry groups learn over time to petition for quota-based rather than tariff-based protection.

IPE and The Security Dilemma

The other day Stephen Walt wrote this about the U.S./Saudi arms deal (that Alex blogged about here):

But my real question is this: if our primary goal is to discourage Iran from developing nuclear weapons, then might this new initiative be counter-productive? Doesn't it just give Iran an even bigger incentive to get a nuclear deterrent of its own? Think about it: if you had a bad relationship with the world's most powerful country, if you knew (or just suspected) that it was still backing anti-government forces in your country, if its president kept telling people that "all options were still on the table," and if that same powerful country were now about to sell billions of dollars of weapons to your neighbors, wouldn't you think seriously about obtaining some way to enhance your own security? And that's hard to do with purely conventional means, because your economy is a lot smaller and is already constrained by economic sanctions. Hmmm....so what are your other options.

This is pretty standard IR security analysis, and probably true as far as it goes. (For those interested, there's a very deep body of research on the security dilemma.) But it got me thinking about applications for IPE. A lot of folks are wringing their hands over Sino-American economic brinksmanship along of number of dimensions including trade protections, exchange rate policy, macroeconomic imbalances, sovereign wealth funds, etc. In the news this week is the Sino-Japanese brinksmanship that is partially about economics, and partially about security. See here for one summary of the situation, here for a discussion of how China's perceived belligerence is helping the U.S. make stronger ties with other Asian states, and here for Drezner marveling over how inept the Chinese appear to be.

(Drezner is surprised by this; I'm not, because Thomas Friedman has recently been writing about how wise and capable the Chinese are. Since Friedman is always wrong about everything, I just assumed the Chinese government would make some blunders in short order. Betting against Friedman: Safest play in town.)

Does any of this conform to the logic of the security dilemma? I think it might. Krugman, for example, has encouraged the U.S. to retaliate against China's exchange rate management by threatening to raise tariffs. He's also suggested that the U.S. threaten similar actions if Germany does not pursue looser monetary policy. He suggests that this is necessary for the U.S. to protect itself against negative externalities being generated by those countries. In other words, Krugman is suggesting using tariffs in self-defense. We wrote a series of posts here discussing why Krugman's "get tough with Chermany" attitude was unlikely to benefit the U.S. in any way. We didn't touch on the logic of the security dilemma, so I'll illustrate it briefly here.

Suppose we do make those threats, and suppose those threats are perceived as credible*. Even further, suppose we get multilateral support from Japan, the U.K., and other leading states in an attempt to pressure China from all sides. Krugman believes that this would lead to major concessions from China. If those threats were issued, had multilateral backing, and were somehow made credible, that might be enough to extract concessions from China. But it might not be. If China feels threatened, it might escalate the situation by further manipulating the RMB, adding new protections for domestic firms, or pursuing preferential trade arrangements with other states. In other words, China may try to preemptively shield themselves from the U.S.'s threat. After all, China might think, the U.S. faces stronger domestic political constraints that we do, so they'll be forced to back down first.

Now it's the U.S.'s turn. Rather than drawing down as we had hoped, China has re-upped. Do we respond in kind? Politicians are not very good at letting sunk costs go, so perhaps we'd respond to China's new policies by doubling down on our own. Rinse, lather repeat. There's a reason these things are called trade "wars", and the reason why we've spent so much time constructing and strengthening multilateral institutions like the WTO is to prevent this type of spiraling from occurring.

The logic of the security dilemma also applies to the China-Japan squabble, as China has responded to Japan's detention of a Chinese national by restricting exports of rare earth materials to Japan. This is already having the effect of moving other Asian nations closer to the U.S. as a means of defense, and may prompt Japan to retaliate in other ways.

This is all pretty basic, but I don't often see the security dilemma applied to IPE subjects. Are there other extensions of the logic that I'm missing?

*Two exceedingly unlikely ifs, I know, but just go with it.

Geithner Files

Things I learned from Joshua Green's very long (but excellent) profile of Timothy Geithner:

1. Contrary to popular belief, Geithner was not only aware of the dangers of derivatives and off-balance sheet transactions, but he spoke out about them repeatedly over a number of years. His talk about "fat tails" sounds like it came straight from Nassim Taleb.

2. Bush was routinely lambasted for not properly vetting administration officials, as was McCain during the campaign, but Obama seems to have chosen Geithner based primarily on one hour-long interview. True, Geithner had great references, but given the context -- the height of the financial crisis and administration of the new TARP program -- it still is a bit odd.

3. The Geithner financial crisis plan was forged in the Tequila and Asian crises in the 1990s. The plan: get the muscle of the government involved early and often, or deeper and more costly intervention will be necessary later. No surprise there. But the price of government involvement might be: "shut down weak banks, bust up oligarchies, and clean up corruption. Then withdraw." This is not the popular view of the government bailouts, but I think it expresses the pattern of government involvement pretty well.

4. The entire orientation of the Geithner plan was to minimize government involvement. That's why the stress tests happened, why the banks weren't nationalized, why TARP was structured the way it was. The goal was to recapitalize the banking sector by maximizing private sector input, and thus save taxpayers hundreds of billions, if not trillions, in the process. It was a big gamble, but it seems to have paid off pretty well.

5. Criticisms of Geithner as being too friendly to Wall Street are spot on: he has systematically resisted punitive measures against banks, and has even argued against tight monitoring of how TARP funds are used. The interesting thing? Unlike almost anyone else in senior levels of any recent presidential administration, he's a career bureaucrat. He's never worked on Wall Street, and recently turned down the presidency of Citigroup.

6. Geithner is a pragmatist above all else: “In a crisis, you have to choose: Are you going to solve the problem, or are you going to teach people a lesson? They’re in direct conflict.” This is not good horse-race politics, but if it leads to better outcomes it may be the best political strategy possible.

7. As I've mentioned before, TARP is turning out to be an exceptional bargain. Here's some figures:

Geithner likes to point out that after a year on the job, he’s spent $7 billion recapitalizing financial firms while private investors have put up $140 billion. TARP money is being repaid faster than anyone imagined, and if Obama gets the $90 billion tax on big banks he proposed in January, it could eventually be recouped. It’s likely that the cost to taxpayers will be much less than the 5 to 10 percent of GDP that the Cleveland Fed says is typical for a crisis, and possibly as little as 2 to 4 percent—about the cost of the much smaller savings-and-loan crisis of the 1980s. A recent Treasury study indicates that it could be less than 1 percent. By any reasonable standard, this would be an impressive achievement, and it would owe a great deal to Geithner’s strategy.

Green has some criticisms too, but they are pretty boilerplate: regulatory reform hasn't been strict enough, etc. Still, the overall picture that emerges is that Geithner has helped saved US taxpayers quite a lot of pain, and quite a lot of money, by taking the actions he did.

The U.S. Plays Chicken with the BRICs

A few days ago, Dr. Oatley wrote about the attempt by the U.S. House of Representatives to cap greenhouse emissions and coerce other countries into doing the same:

This time it is the Waxman-Markey cap and trade legislation. The intent of the legislation--reduce greenhouse gases--addresses concerns of the Democrats' median voter, who cares deeply about climate change. Producers, however, are concerned that the higher energy costs generated by cap and trade will disadvantage them relative to Chinese firms who are not facing higher energy costs because China does not regulate greenhouse gases. The solution, added late to the legislation, is to impose tariffs on goods from countries that do not regulate GHG (i.e., China). Nobody really wants to impose tariffs, but the hope is that the threat of tariffs will be sufficient to induce China to agree to international regulations on CO2 emissions.

This realist view is often borne out in the politics of international regulations. But in this case it is difficult to see whether the U.S. has the muscle to coerce China (and others) into adopting the U.S.-preferred strategy. Krugman loves it, but the push-back from China and India has already begun:

The Chinese government also said it believed the carbon tax proposal violated the principle set out in the Kyoto protocol that developed and developing countries should respond to climate change together but with different responsibilities. “[It] severely harms developing countries’ interests,” Mr Yao said.

The WTO report, which gave a cautious nod to carbon tariffs, was prepared by the organisation’s secretariat, which can advise and facilitate discussion among the WTO’s members but does not set the rules itself. If a government such as China’s challenged such taxes, the case would be decided by the WTO’s dispute settlement system – panels of independent trade experts and lawyers.

Some trade lawyers point out that past WTO decisions have permitted governments to restrict trade in order to protect natural resources. But others say the case law is patchy, and it is hard to prove that such measures are being applied in a fair and consistent manner – a necessary condition for meeting WTO rules.

And the Indians have quite a point:

With 1.1bn people – roughly a sixth of the world’s population – India has one of the lowest per capita emission levels, with 1.2 tonnes per head, about 4.6 per cent of total global emissions. “India has not polluted – we are bearing the brunt of global climate change caused by the developed countries and we are being asked to curb emissions,” he said. “I find this ludicrous.”

However, India’s carbon emissions are expected to rise sharply in the future, especially as the country tries to meet its power deficit through the rapid development of generating capacity. India uses about 450m tonnes of highly-polluting coal for power generation each year, a figure that Mr Ramesh said would rise to about 1bn tonnes in less than a decade.

“There is no running away from our karma – without coal, we have no economic future,” he said.

That last sentence is the crux: India and China will not yield because they cannot. They can credibly commit to hurt U.S. consumers and producers in retaliation (in this case, retaliation could be as simple as accepting reduced economic gains from trade; of course, they could also slap retaliatory tariffs or simply stop buying U.S. bonds). So the question is whether the U.S. thinks that the environmental gains from carbon tariffs will out-weigh the economic costs of a trade war during a nasty recession. More specifically, does the president and the 60th most-progressive senator think so? So far, Obama has indicated that he is not interested in playing chicken with the Chinese.

From my seat (nowhere near the table), it appears that the provision will be stripped from the Senate version of the bill, and/or the bill will not pass. The costs to American consumers of challenging China and India (and Canada) have already become too great. That could change if the U.S., E.U., Japan, and others make a concerted stand against the BRICs, but that would allow the BRICs to accuse the rich world of preventing the development of some of the world's poorest people in order to fulfill their pet preferences. And they would be right.

Addendum: China may have actually started the trade war over a month ago.

Pass the Cheese

Happy Day! The U.S. and E.U. have reached an agreement (pending approval by the necessary governments) whereby the U.S. lowers its prohibitive tariffs on Roquefort cheese, Italian mineral water, and other E.U. delicacies in exchange for laxer E.U. prohibitions on American beef. Believe it or not, but this brouhaha has lasted for 13 years, although it was amped up this Winter when Pres. Bush, in one of his last acts in office, hiked up these tariffs to bring the situation to a head (and then pass it off to Obama).

On the (De)Merits of Liberal Illiberalism

Economic infidel Emmanuel (hey, he asked for it) fulfilled his promise to further explain his support for a low-level trade war between the U.S. and China. It's a long post, summoning Adam Smith and Jesus Christ among other luminaries, but I feel it is short on persuasion. For one thing, in my last post I proposed two scenarios for achieving a re-balancing of accounts: the first is Emmanuel's trade war; the second, a mix of currency revaluations (i.e. the RMB strengthening against the dollar) and domestic policies to encourage domestic spending in China (e.g. social welfare spending). If the real problem is as Emmanuel sees it, then the second scenario attacks the problem head-on by addressing the factors causing the account imbalance; instigating a trade war doesn't address the problem at all except by slowing overall economic activity. This proposed cure seems much worse than the actual disease, especially from the Chinese point of view. Emmanuel didn't speak to my question directly, but his post indicates that he prefers the war nonetheless. I remain unconvinced, as I hope to explain below.

I certainly agree that the current trade regime between the U.S. and China is not "free". But Emmanuel points out several ways in which the trade policies are illiberal, complains about them, and then proposes more illiberalism as a counterweight! He's proposing illiberalism as a liberalism-in-disguise. It's a sort of Wouldn't it make more sense to advocate for China to allow the RMB to appreciate, the U.S. to let the dollar depreciate (we've been trying our damnedest!), and for China to weaken its system of export subsidies in favor of policies likely to stimulate domestic spending (e.g. some version of an EITC or something)? In past posts (and later in the one under discussion), Emmanuel has been sympathetic to those views, so why has he jumped on the protectionist bandwagon now?

Emmanuel correctly points out that there is a social justice aspect to this. But it's not clear that it cuts always and only in the direction that he intends. If a trade war ensues, the first thing to happen will be a somewhat major rise in unemployment (above and beyond the jobs lost to opportunity costs), especially among the already-poor in China. And if employment drops, it will be difficult for China to boost domestic consumption. The necessity of boosting Chinese domestic consumption is the central issue here, as I think Emmanuel and I both agree. So if Obama starts a trade war with China, the Chinese people lose jobs and become poorer, domestic consumption falls further, and Chinese welfare has dropped. Where's the social justice in that? Perhaps the statistical account imbalance has lessened, but at great cost in welfare.

Emmanuel similarly complains about zombie corporations, and cites the Japanese experiences of the past decade or so. I have that experience in mind as well, but I don't understand how propping up inefficient local industries through mercantilism is supposed to decrease the number of zombie firms. Indeed, the opposite is likely to be true, as the U.S. has already seen (viz.: the Big Three automakers, and the U.S. steel industry). Creating more domestic protections -- through subsidy or import tax -- will further soften the underbelly of American industry, and prolong the adjustment Emmanuel is seeking.

He is similarly wrong about America's debt obligations. While American debt is certainly not negligible, it's also not extreme. American debt levels as a percentage of GDP are somewhat middle-of-the-road for OECD countries. Japan, Italy, France, Greece, Belgium, even Germany (!) all have higher debt-to-GDP ratios than the U.S., which is right around the OECD mean. Of course, the U.S. debt level is sure to go up in the next few years, but the point is that there is still some wiggle room before the debt burden becomes unmanageable. One other not-insignificant point is that all of the U.S. debt is dollar-denominated, which makes servicing that debt much easier, especially over long time horizons.

So we agree on the need for structural adjustments in both the U.S. and China, but we disagree on the mechanism. Emmanuel seems to think that adjustment is best achieved through a trade war, whereas I think that a trade war will prolong the adjustment period by propping up national champions and zombie firms. And, as Bhagwati is fond of saying, it's much easier to enact protectionist measures in bad times than it is to retract them in good times: once interests are entrenched, they tend to stay entrenched (see, e.g., the U.S. Farm Bill). To me, a better policy would be keep trade open, lower the existing barriers to trade, make the playing field equal for producers of Chinese domestic goods, and boost the American export sector through greater currency parity. This could lessen the pain of the transition by not killing aggregate economic activity.

Is my option politically feasible? Emmanuel seems to think not; that only a trade war can force the Chinese and American governments to take the necessary steps. This is not obvious to me, and in fact it seems more likely that the opposite is true: if the U.S. puts up tariffs, the Chinese may respond with even greater export subsidies, or even greater currency manipulation. In fact, the recent pattern of Chinese behavior indicates this as the most likely outcome. And if that happens, then what? I'd rather work for actual liberal policies rather than illiberal liberal ones, even if the changes are incremental rather than drastic. In my view, a small positive change is preferred to a large negative change any day of the week. I fear that Emmanuel's approach is one step forward, two steps back.

Should We Hope For More Protectionism?

Emmanuel at IPE Zone says that a trade war between China and the U.S. might not be such a bad thing after all:

I will have more on why a trade war could be a potentially welcome development as the US and China wage a tit-for-tat strategy of faulting each others' trade practices and launching sanctions. Unlike conventional economists who view protectionism as an unambiguous bad or anti-globalization types who view trade as little more than the work of Satan, there is more to it than that. As always, the IPE Zone is less about pleasing either crowd than about forging ahead with fresh thinking on various problematiques. Yes, a trade war may just be the thing to remedy global economic imbalances currently roiling globalization. All we need is an Obama-induced escalation. Watch this space.

I will, but color me skeptical. There's a reason "conventional economists" are frightened of a trade war: it distorts economic activity, increases inefficiencies, carries the deadweight loss of the tax and of the lost scale returns, and so reduces output. In the midst of the worst global economy since the Great Depression, that seems to be the last thing we should be seeking. Additionally, the Chinese economy is heavily dependent on exports; if that system collapses suddenly rather than gradually, then it seems inevitable that social welfare will decrease sharply, and the brunt of it will be felt by the Chinese.

Emmanuel seems to think that these negative prospects will be out-weighed by an improvement in "global economic imbalances". But will they? Let's go through the logic. Suppose the Chinese government -- now facing a potentially severe domestic recession -- is facing two policy choices: attempting to rebalance their economy by boosting domestic consumption, or instigating a trade war with the U.S. to protect local industries. In the first scenario, the Chinese government could let the value of the RMB rise relative to the dollar; this will hurt exporting producers, but will make imports relatively cheaper. If coupled with a shift in subsidies from export industries to domestic consumption programs (e.g. direct subsidies to Chinese consumers, through unemployment insurance or some other social welfare plan) then domestic consumption might be boosted while the balance-of-payments gap narrows. The shift from an extremely export-biased economic model to a more balanced model would not be without some pain, of course, but that adjustment is going to have to happen eventually anyway.

In the second scenario, the Chinese and Americans end up in a trade war. Because 40% of the Chinese economy is in exporting industries, national income falls precipitously while unemployment rises. This lessens domestic demand for goods in China, and the Chinese economy slips into a deep recession. The value of the RMB slips further, making imports even more expensive and diminishing local demand further. The current account surplus narrows, but only because overall economic activity has decreased. In this scenario, spiraling is a very real danger.

Both scenarios lead to the re-balancing Emmanuel seeks, but the second seems to entail much more pain. And this pain wouldn't remain local; it would trickle down throughout all the export-biased economies in Asia. All to say, I have no idea what Emmanuel has in mind, although I'm very interested in finding out.

Obama on Trade

Today I voted for Obama for president, but I did so with some reticence. On balance, I feel that he is a much more acceptable candidate than McCain, but this does not make him above reproach. One columnist for The Times of India channels some of my concern:

McCain is one of the few American politicians in either party with the courage and conviction to stand up to protectionist populism. By contrast, Obama embodies protectionism.

Look at the accompanying chart. It shows that McCain has voted 88% of the time against bills creating trade barriers, and 90% of the time against export subsidies for US producers. Few other senators have such a splendid record.

Obama has served a much shorter time in the Senate, and avoided voting on many key issues. He has voted against trade barriers only 36% of the time. He supported export subsidies on the two occasions on which he voted, a 100% protectionist record in this regard. ...

Unlike Obama, McCain voted against imposing trade sanctions on China for supposedly undervaluing its currency to keep exports booming and accumulate large forex reserves. India has followed a similar policy, though with less export success than China. But if indeed India achieves big success in the future, it could be similarly targeted by US legislators and, will need people like McCain to resist.

Obama favours extensive subsidies for US farmers, hitting Third World exporters like India. This has been one of the issues on which the Doha Round of WTO is gridlocked. McCain could open the gridlock, Obama will strengthen it.

Obama also favours subsidies for converting maize to ethanol. The massive diversion of maize from food to ethanol has sent global food and fertiliser prices skyrocketing, hitting countries like India. But McCain has always opposed subsidies for both US agriculture and ethanol. While campaigning, he had the courage to oppose such subsidies even in Iowa, an agricultural state he badly needs to win if he is to become president.

There is more at the link, but this commentator isn't the first to express concern over Obama's protectionist leanings. Indeed, some have gone so far as to argue that Obama is actually lying, and if elected would actually follow in W.J. Clinton's footsteps on trade. Austan Goolsbee, one of Obama's chief economic advisors, intimated as much to representatives of the Canadian government after one NAFTA-bashing session earlier in the campaign. Perhaps. But Obama's voting record and rhetoric argue against the idea. One of the many major policy mistakes of the Great Depression was the institution of the Smoot-Hawley Tariff. A similar move at this juncture might be similarly disastrous. In my view, this is a strictly non-partisan issue; regardless of who we personally support for president, we should hope that if Obama is elected he will have learned from history.

Tariffs: the Regressive "Gender Tax"?

We too often think about the broad consumer surplus loss tariffs impose without thinking much about how these losses are distributed among consumers. That tariffs are regressive (i.e., weigh more heavily on low-income households than high-income households) is commonly known. Less commonly recognized is that, at least in apparel, tariffs also discriminate on the basis of gender.

What I find most amusing about the NYT story is the apparent bewilderment: "But after years of poring over dusty tariff lists, international trade court records and Congressional testimony, lawyers have found nothing that explains why, say, the tariff on an imported wool suit is 8.5 percent for a woman and zero for a man. “It’s irrational,” said Peter Bragdon, the general counsel at Columbia Sportswear, one of the companies suing the government."

No, it's not irrational, it's politics. Resolving this puzzle by showing how these inequities arose would be an interesting paper (or honors thesis). Are these accidental, or do they reflect something systematic about tariff politics?